Preferred equity is any ownership participation with priority over common equity. Broadly, special classes of stock express this position. In real estate, though, it takes the form of limited liability corporation or limited partnership interests.
It entitles investors to guaranteed dividend payments whether or not common shareholders receive them. If the project is more successful than anticipated, though, the sponsor might increase the common dividend. However, the sponsor would continue to pay only the agreed-to dividend to preferred equity holders.
Benefits of preferred equity for project sponsors and investors
This source of capital can provide a project sponsor with more funding at a lower cost than common equity. Sponsors offer these securities if they’re unable or unwilling to commit enough capital to satisfy lenders’ requirements.
Investors, for their part, get a higher yield than the lenders. Meanwhile, they still hold a more secure position than common equity holders.
In the capital stack
The capital stack, which ranks the levels of capital by riskiness, has the safest — senior debt — at the bottom and the most speculative — common equity — at the top. Preferred equity is one layer down from the top.
Some consider it to be a form of mezzanine debt. Legal services platform Upcounsel distinguishes between “hard” and “soft” preferred equity depending on its similarity to debt or common equity, respectively.
Still, this layer isn’t technically debt. As a result, preferred equity holders usually don’t have to coordinate their lien position with the mortgage lender or other creditors. As a result, the sponsor might be able to speed up capital raising and break ground sooner.